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Arbitrage crashes and the speed of capital

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  • Mitchell, Mark
  • Pulvino, Todd
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    Abstract

    The imminent failure of prime brokers during the 2008 financial crisis caused a sudden decrease in the leverage afforded hedge funds. This decrease resulted from the asymmetrical payoff to rehypothecation lenders—the ultimate financiers, through prime brokers, to hedge funds. Seemingly long-term debt capital became short-term capital creating a duration mismatch between left-hand side arbitrage opportunities and right-hand side liabilities. Consequently, arbitrageurs became unable to maintain similar prices of similar assets. Mispricing magnitudes, and the time required to correct them, reflect the role of arbitrageurs in maintaining accurate prices during normal times and offer an estimate of discounts at which assets transact during crises.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 104 (2012)
    Issue (Month): 3 ()
    Pages: 469-490

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    Handle: RePEc:eee:jfinec:v:104:y:2012:i:3:p:469-490

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Arbitrage; Financial crisis; Hedge funds;

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    References

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    Cited by:
    1. Oh, Ji Yeol Jimmy, 2014. "Ambiguity aversion, funding liquidity, and liquidation dynamics," Journal of Financial Markets, Elsevier, vol. 18(C), pages 49-76.
    2. Lakicevic, Milan & Shachmurove, Yochanan & Vulanovic, Milos, 2014. "Institutional changes of Specified Purpose Acquisition Companies (SPACs)," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 149-169.
    3. Markus K. Brunnermeier & Martin Oehmke, 2012. "Bubbles, Financial Crises, and Systemic Risk," NBER Working Papers 18398, National Bureau of Economic Research, Inc.
    4. Cao, Charles & Liang, Bing & Lo, Andrew W. & Petrasek, Lubomir, 2014. "Hedge fund holdings and stock market efficiency," Finance and Economics Discussion Series 2014-36, Board of Governors of the Federal Reserve System (U.S.).
    5. Jaewon Choi & Or Shachar, 2013. "Did liquidity providers become liquidity seekers?," Staff Reports 650, Federal Reserve Bank of New York.
    6. Hanno Lustig, 2013. "A European History Lesson for Today’s Central Bankers," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 109-120, March.

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